What is Realtive Strength

I received a question about Relative Strength (RS) in the comments of a recent post.

I have spent many hours reading and studying your blogs; best on the web! I am very anxious to see your new site. In the meantime, I have a question about relative strength. I have a mild understanding of relative strength based on my own research but can you explain RS in more detail especially the meaning and importance of RS numbers and how they fit into an investor’s strategy. For me, your post on January 22, 2006 that looks at Coach (COH) and Tower Group (TWGP) would be a good place to begin.

Thank you. Keep up the good work.

Paul Trombley

Paul,
Relative Strength (RS) is calculated by dividing the stock’s price by the value of a specific index (the S&P 500 in the case of IBD). It is also a measure of price trend that indicates how a stock is performing relative to other stocks in its industry.

The RS line is helpful in determining whether a stock is outperforming or lagging the general market and/or it’s industry peers.

A new relative strength high may be an indicator that a stock is prepared to make a new price high and a new relative strength low that precedes a new low in the stock can be a warning sign that a stock is in trouble and possibly going lower. (This is what I detailed in the COH and TWGP posts in early 2006).

*Today’s Top 10 RS Stocks are Listed at the Bottom of the Post (with Charts)*

Stock leaders are typically making new highs and we want to ride the trend of the leaders. These leaders also possess the strongest relative strength readings in the market. The idea is to establish a position within a leader that is increasing in price and relative strength. As long as the stock is outperforming the market and other stocks, the RS strength will rise.

Digest this quote from William O’Neil from IBD:

Look for leading stocks: Our study of the greatest stock market winners found that all-star stocks had, on average, outperformed 87% of the market before they began their most dramatic price advances. In a manner of speaking, if you want to find next year’s winning stocks, look at the better-performing stocks today.

Once a general-market decline is definitely over, the first stocks to bounce back to new price highs are almost always your authentic leaders.

Top 10 RS Leaders in my Research (as of today):
*FYI: This doesn’t automatically make them a buy*